“Traditional measures of innovation such as market success are significantly lagging indicators. We’re interested in measures that are timely, meaningful, and, most importantly, actionable.”

David Burrage, Motorola research portfolio and processes manager, in Business Week, 28 April 2006

How does your organization measure its innovation performance?

Based on research we’ve done recently at the ICE Center, there seem to be several common themes and issues around commercializing innovation, applying to both new products and services.

First, innovation effectiveness is an area of perennial concern — senior executives are always interested in assessing their company’s innovation performance. At the same time, however, most companies do not have a systematic or standard way of capturing either investments in, or returns from, innovation. As a result, measurement of innovation performance tends to be ad hoc in most companies, with considerable variation in measures used from year to year.

Because innovation performance is not measured systematically, it doesn’t play a strong role in the performance evaluations of senior management. For example, most senior managers have a growth target for their division or company, and they may be rewarded based on their ability to achieve this target. The mechanisms by which they attain this growth, however, are usually unspecified. Thus, all growth contributes equally, whether it comes from acquisition or from innovation.

At the ICE Center, we’ve been looking at the ways that companies measure innovative activities for several years. We’ve found it useful to distinguish across three categories of measures:

1. Results-based measures, which focus on business outcomes, such as sales or profits, stock price or market valuation;

2. Process measures, which capture the activities that contribute to these business outcomes, such as number of projects in the pipeline, time to market, or percent of sales from new products.

3. Project measures, which look at the returns and investments from specific innovation projects. Measures such as “time to cash” or ROI are calculated on a project-by-project basis;

Each set of measures have their advantages and limitations. Here’s a brief rundown.

Results measures – accounting for growth

Most companies pursue innovation so that they can realize higher growth in sales and profits – they create and launch new products, services, or businesses which can increase revenues or margins. But innovation is just one of many ways to get growth, so simply looking at overall growth rates does not capture innovation’s contribution. For organizations without a strong history of innovation, for example, growth often comes via acquisition or geographical expansion.

Companies could use growth accounting techniques to decompose the sources of a company’s sales or profit growth. Economists have taken this approach in understanding sources of growth for the national or global economy (where they find that innovation plays a major role in contributing to total economic growth). Companies could use a similar approach to decompose a company’s growth into contributions from such factors as innovations, acquisitions, and geographical expansion.

Regardless of the kind of accounting you use, as Motorola’s David Burrage noted above, the results-based measures are lagging indicators of innovation capability – they show the results of a company’s past efforts, but don’t provide good direction on the kinds of activities companies should undertake to get to these results.

Process measures – leading indicators of innovation performance?

Wouldn’t it be great to have a few leading indicators of innovation performance – measures that could tell you how the company will be doing in the future, rather than being a reflection of the past?

Process measures, which look at innovation activities within the organization, may provide some of these leading indicators. Here are a few types of popular process measures:

Ø Number of innovation projects being undertaken;

Ø Average time to market;

Ø Number of patent applications per year;

Ø Percent of sales from new products or services.

The assumption underlying process measurement is that doing the right activities will lead to improved business results. The problem, however, is that it’s difficult to find the right activities to measure as the right leading indicators.

And putting too much emphasis on process measures often leads to counter-productive business results. For example, measuring the percent of sales from new products or services rewards product churning — the substitution of a new product for an older product that may not have needed replacement. The new products substitute for the old, generating expense without adding any revenue. When this happens, new products can actually contribute to reduced profitability.

Project Measures – returns from specific projects.

Project measures are especially prevalent in industries, like pharmaceuticals, where innovative efforts are undertaken in large and discrete projects.

In these situations, there are a number of tools that can provide a measure of project-based innovation performance. In their recent book Payback, BCG consultants Jim Andrew and Hal Sirkin describe the “cash curve” for different kinds of projects. This builds on the “breakeven time” concept first developed by Hewlett Packard in the mid-1980s. In both measures, the idea is to minimize early investment and maximize cash returns.

It sounds simple, but it’s surprising how many major innovations become cash traps. Andrew and Sirkin highlight such products as TiVo, Motorola’s Iridium Satellite Phone, and the Supersonic Concorde as innovations which had a small chance of success from the start because of the high upfront investments required. On the other hand, Apple made a number of decisions in its iPod development that created the conditions for an extremely profitable new product.

Project measures tend to treat each innovation as a separate business, and measure returns on that basis. For most companies, however, innovation projects are embedded into departments that have many other responsibilities as well, like marketing, engineering, or sales. In these situations, it’s both impractical and inaccurate to allocate shared investments between projects.

All three kinds of measures have their advantages and their drawbacks. Many experts recommend using a dashboard or scorecard that contains a combination of results, process, and project measures. The situation for most organizations currently, however, is a much more ad hoc approach to determining the metrics of innovation success.

How do you measure innovation performance? Drop me a line if you’d like to discuss your approach – we’re collecting information for our next Idea-to-Profit Summit in May.

More Information:

1. If you’re interested in the way innovation is measured in economies, rather than companies, Gavin Cameron, of Nuffield College at Oxford University, provided a survey of Innovation and Economic Growth. That’s available here.
2. In December 06, the US Department of Commerce launched an industry/ academy effort to look at the way we measure innovation in the US.
3. Business Week did several articles on company measurement do’s and don’ts. Here’s one of them, from which I took the Motorola quote above.
4. The book Payback by Andrew and Sirkin is available from Amazon here.